When it comes to investing, many people are looking for alternatives to the stock market. One of the options is to engage in peer-to-peer lending. There are many ways for you to get involved with P2P lending, but quite possibly one of the most intriguing is by making microloans to entrepreneurs. This option appeals to many people because it allows them to help others while at the same time providing an opportunity to earn money, often at above-market rates. Borrowers go to the P2P market to get faster access to cash with fewer restrictions than traditional bank loans.
According to Global Market Insights, the P2P market reached $209.4 billion in size in 2023 and is slated to grow at a compound annual growth rate of 25% through 2032. With the P2P market already quite large and still growing rapidly, it pays for both investors and borrowers to check it out. To that end, here’s a deeper dive into P2P loans and how they work.
What Is Peer-to-Peer Lending?
Peer-to-peer lending allows individuals to borrow from investors — “peers” — instead of banks. Borrowers apply for loans on a P2P platform, providing information about the interest rate on the loan, how the funds will be used, and for how long. Individual investors can select which loan they want to fund based on this information.
Popular sites for P2P lending include LendingClub, Prosper and Funding Circle. You’ll have to do your own research to figure out which of these popular platforms is the best match for your needs.
How P2P Loans Work for Borrowers
The P2P loan process for borrowers is similar in general terms to applying for a loan through the bank. However, funding is usually faster with a P2P loan, and the documentation requirements are generally less. Here are the four steps to applying for a loan through a P2P platform:
- Application process: Borrowers submit loan requests through an online platform.
- Credit evaluation: The platform assigns a risk rating based on creditworthiness.
- Loan funding: Individual investors choose to fund the loan, either fully or partially.
- Repayment terms: Borrowers make fixed payments with interest over time.
How P2P Lending Works for Investors
Investors go to the P2P market to earn higher rates of interest or fund worthy causes, or both. Here are the steps that lenders need to take:
- Create an investor account: Individuals sign up on a P2P platform.
- Selecting loans to fund: Investors choose loans based on risk and expected returns.
- Diversification strategies: Investing in multiple loans to spread risk.
- Earning returns: Investors receive monthly repayments with interest.
P2P Lending vs. Traditional Loans
In some ways, P2P lending resembles traditional lending. However, there are some important differences. Here’s a side-by-side comparison of P2P lending and traditional loans:
| Feature | P2P Loans | Traditional Loans |
|---|---|---|
| Loan source | Individual investors | Banks or credit unions |
| Interest rates | Varies by borrower risk | Fixed or variable |
| Approval speed | Faster, online process | May take longer |
| Eligibility requirements | More flexible, varies by platform | Stricter credit and income requirements |
| Risk for lenders | Higher, due to borrower default | Lower, due to collateral and regulations |
Who Should Consider P2P Lending?
P2P lending has some definite advantages over working with a traditional bank. However, it’s not for everyone. Here are the types of investors and borrowers that might benefit from using a P2P platform:
- Borrowers:
- Those who struggle to qualify for bank loans
- People looking for a quick, unsecured personal loan
- Small business owners needing alternative funding
- Investors:
- Individuals seeking higher returns than traditional investments
- Those willing to accept higher risks for potential gains
- People looking to diversify their investment portfolio.
How To Get Started with P2P Lending
Getting started with P2P lending is relatively straightforward. The process varies a bit for borrowers and investors. Here’s a look at the steps you’ll need to take:
For Borrowers:
- Research P2P lending platforms and compare interest rates.
- Check eligibility requirements and credit score guidelines.
- Apply and wait for funding.
- Review loan terms carefully before accepting.
For Investors:
- Choose a reputable P2P lending platform.
- Set an investment budget and risk tolerance.
- Diversify investments across multiple borrowers.
- Monitor loans and reinvest payments for growth.
Final Thoughts
Peer-to-peer lending has both pros and cons. On the one hand, it offers an alternative to traditional loans and investing for borrowers, who can also access funds quickly, though they may have to pay higher interest rates. They may also have little information about their lender. However, the positives often outweigh the negatives, especially for borrowers who are struggling to find traditional financing.
Investors can earn strong returns, oftentimes higher than they can get from traditional bond markets or bank products. However, they are responsible for managing their own risk. Although information about borrowers is vetted to some degree by the P2P platform, there are still risks, from borrower insolvency to platform bankruptcy to outright fraud. As with any investment, lenders should do their own due diligence and ensure that a P2P loan matches their investment objectives and risk tolerance.